Real Estate
Tailwinds Supporting the Residential Rental Sector
Article
Apr 19, 2022
The residential real estate sector—composed primarily of multifamily and single-family rentals—has produced strong returns in recent years, as rents and property values have increased.
Annual apartment rental revenue growth hit a more than 20-year high in 2021, according to commercial real estate industry research firm Green Street. Additionally, single-family rentals are experiencing record occupancies, helping drive double-digit rent growth. Many investors are now wondering whether this strength can persist. We believe it can, thanks to these tailwinds.
TAILWINDS
The shortage of for-sale inventory is not an easy problem to solve. The primary factor driving recent strength across residential rentals is the lack of affordable homes for sale. Construction of new homes over the last decade has slowed significantly from historical levels and has not kept pace with demand. Our analysis shows that construction of new housing over the last 10 years is 3 million units shy of where it should be, based on long-term historical annual averages.
This "underbuilding gap" has helped drive up housing prices, making homeownership less affordable and accessible, and increased the attractiveness of renting. Rents and rental property values have risen in response. We expect this trend to persist, as we estimate it will take years for for-sale inventory to match up with demand, even as we are beginning to see more supply hit the market. Rising inflation is sending input and labor costs higher, raising building costs and holding back new construction. Some markets also have space and/or regulatory constraints on new supply.
Shifting demographics and housing preferences are supportive. Another key demand driver for U.S. rental housing is the changing demographic landscape. Millennials, those ages 25 to 40 in 2021, are currently the largest generation group in the U.S.1 This age cohort historically has represented first-time homebuyers. However, millennials face challenges today amid the prospect of rising mortgage rates, along with high levels of debt, a five-decade low in entry-level housing supply and rising home prices. These challenges may be keeping some millennials renting rather than purchasing. Meanwhile, baby boomers (ages 57 to 75), the second-largest generation,2 may be downsizing in an uncertain economic environment and increasingly renting as well as a result.
At the same time, while we expect that workers will return to offices, a hybrid home-and-office schedule will likely become the norm for many. In the housing market, this should translate into demand for larger rentals to accommodate a shift toward more work from home.
Rents in Sunbelt markets should remain strong. The strength of U.S. Sunbelt real estate markets is a theme we have been discussing for some time—even before the COVID-19 pandemic. The pandemic has only accelerated migration from America’s largest northern and coastal metropolitan areas to Sunbelt markets—the population centers of the Southwest and Southeast. Densely populated urban lifestyles reliant on public transportation became less attractive during the pandemic, as people and companies alike sought more space and greater affordability, and remote work and jobs growth made these moves even more compelling.
As a result, many Sunbelt markets have experienced very strong rent growth in recent years. We believe this growth is likely to persist for years, as companies and individuals continue to migrate to midsize southern cities, drawn by lower costs, attractive quality of life, better weather, lower taxes and more business-friendly environments. And this trend is likely to especially benefit single-family rentals, which make up a larger portion of Sunbelt residential rental markets.
Coastal market rents could experience a sharp rebound. Apartment rents in the nation’s largest northern and coastal metropolitan areas dramatically fell at the onset of the pandemic in 2020. Residents relocated to more suburban and rural regions amid remote work and school. Since then, as governments have relaxed restrictions to combat the health crisis and infection rates have come down, people have returned, and urban rents have largely recovered to pre-pandemic levels. We believe large global cities will continue to be the places where employers need to be to hire the best—and most diverse—talent in the world.
As a result, we believe rent recoveries in these markets are in the early stages. Recent data suggest a slowing in the pace at which Sunbelt market rents are outpacing coastal counterparts. The chart below, which compares rent growth by market type, shows that the relative strength of Sunbelt markets peaked in the summer of 2021. So while rent growth in Sunbelt markets remains stronger overall, coastal market rents are experiencing improving rental growth.
A RISK TO OUR VIEW
As rent increases in many markets have outpaced wage growth, local governments have taken notice. Rent control measures are being proposed by lawmakers across the U.S.,3 including in cities and municipalities historically known to be more business-friendly. We are closely watching the progress of these proposals and how the measures may impact rent growth.
We believe an active investment approach can potentially help mitigate regulatory risk. In listed markets, active investors can quickly adjust portfolios as regulatory risks increase or decrease in select regions. On the direct ownership side, managers must take a sustainable approach and partner with key local stakeholders to create long-term value for these assets. Managers that take advantage of near-term supply-and-demand imbalances may risk alienating tenants, politicians and investors.
INVESTING TAKEAWAYS
The multifamily and single-family rental sectors have experienced very strong operating fundamentals in recent years. As a result, asset values have steadily increased amid capitalization rate compression and steady rent increases. While the pace of growth may moderate compared with where it was during the immediate aftermath of the pandemic, the backdrop is supportive. Given the tailwinds mentioned above, we believe the residential sector can maintain its relative strength for years to come and presents a good opportunity for income-generating real estate.
ENDNOTES
1 Source: U.S. Census Bureau, Pew Research Center.
2 Source: U.S. Census Bureau, Pew Research Center.
3 Source: The Wall Street Journal, “Rent-Control Measures Are Back as Home Rents Reach New Highs"; March 13, 2022 (www.wsj.com/ articles/rent-control-measures-are-back-as-home-rents-reach-newhighs-11647180001).
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